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Wall Street loves stranded costs. No kidding. For stockbrokers and underwriters accustomed to selling utility issues to widows and orphans, the prospect of asset-backed financing opens a whole new world. I'm talking here about "securitizing" stranded costs.
In a securitization, a trust takes beneficial title to utility assets (tangible or intangible) that have lost their value in the market, and sells "transition bonds" to a new set of investors, funneling the bond sales proceeds back to the utility and to its equity investors. Who pays the coupon? Why, it's the customer of course. The utility customer ("ratepayer" may be a better term in this context) pays tariffed rates designed by state regulators to recover the stranded costs. The revenue stream just keeps on flowing.
And guess what? Since regulators can't be trusted, the state legislature steps into the game. The lawmakers pass a law that virtually guarantees the collection of revenues which support the bond, even as the trust holds the assets as collateral. The law may well require a true-up mechanism to ensure revenues continue to cover costs (em to compensate for changes in demographics or usage patterns among the customers who pay the transition charges.
Dan Scotto, senior managing director for corporate bond research at Bear, Stearns & Co., puts it this way: "This guaranteed recovery would replace the normal regulatory process (em a balancing of interests (em normally performed by the regulators." Bear Stearns put out a report on utility securitization in February. It notes that California, Pennsylvania and New Jersey already have securitization laws in place, and predicts that Connecticut, New York, Michigan, Texas and Vermont are likely to consider similar laws.
"Once the securities are sold," says Scotto, "neither regulators nor legislators would have the legal authority to interfere with this charge during the lifetime of the bonds."
That's how the game works. Talk about low risk. You'd think the bonds would sell themselves.
"We think it's better than anything in the market," says Tracy Van Eck, senior managing director for asset-backed securities at Bear Stearns, on predicting the success of stranded-asset bonds among other ABS issues.
"Historically," says Van Eck, "New asset types [new categories of ABS issues] have come in at a `new issue premium,' reflecting the need to educate bond investors ... but we think these utilities [ABS issues] deserve the tightest benchmarks."
In other words, rate reduction bonds to securitize stranded costs should sell at the lowest interest rate premium above no-risk debt (U.S. treasury issues) of any asset type in the ABS market, which includes credit card installment debt, home equity loans, auto and truck purchasing and leasing, student loans, equipment lease financing and loans for other assets.
"So where should utility securitization ABSs be traded?" asks Van Eck. "Close to risk free," she says, noting the reliable cash flow, virtually guaranteed by the state law. "It's as close to a tax as you can get."
Floating the Bonds
There are risks, nevertheless, with these new asset-backed securities. But the risks are different from those we usually associate with the typical, corporate-backed